Almost one year ago, President Trump signed into law the Tax Cuts and Jobs Act (TCJA), the biggest tax overhaul in the United States in over 30 years. While the law improved the revenue code in some ways, it falls short on three key dimensions – economic growth, fiscal sustainability, and distributional effects.

Among its many changes, TCJA cut the corporate rate tax from 35 percent to 21 percent, redesigned international tax rules, and created a deduction for non-corporate (“pass-through”) business income. It repealed personal exemptions, expanded the standard deduction, eliminated the tax on people who do not obtain adequate health insurance, and greatly weakened the estate tax. Most of the corporate provisions are permanent, while most individual income tax and estate tax provisions (except for health insurance) expire after 2025.

The TCJA will simplify tax filing for those who will now claim the standard deduction instead of itemizing, and some of its corporate tax cuts will create new incentives for investment. Overall, however, the law makes the tax code worse, not better.

Growth: Tax cuts raise long-term growth by improving incentives to work, save, and invest, but the deficits they create will offset some or all of those gains. Most studies indicate that the long-term impact on Gross Domestic Product (GDP) – the output produced in the United States – will be modest. The impact on Gross National Product (GNP) – the income that Americans receive – will be even smaller. Because the TCJA will encourage foreigners to invest in the United States, the returns they receive will reduce the amount of income that Americans will keep from their production. As a result, Americans will receive no increase in net income in 2028 from TCJA. Of course, TCJA stimulated the economy over its first year, but almost any tax cut that put money in people’s pockets would do that.

Fiscal effects: The CBO estimates that TCJA will increase deficits by $1.9 trillion through 2028, even after incorporating the impact of the new law on the economy. If lawmakers make the temporary provisions of TCJA permanent, the long-term effects will be even more dire.

Distributional Effects: TCJA gave most of its benefits to the wealthy and thus increased the inequality of income, which had already been growing for the past four decades. Tax Policy Center (TPC) estimates show that TCJA increased after-tax income in 2018 by 0.4 percent for households in the lowest quintile, compared with 2.9 percent for those in the top quintile, and even more for the top few percent of households.

About 80 percent of taxpayers did receive a direct tax cut from TCJA, but that is not the end of the story. Tax cuts eventually have to be paid for. When Donald Trump said he was giving Americans a tax cut for Christmas, for example, he neglected to add that they (or their children) eventually would receive the bill. It is unclear how TCJA will eventually be financed, but in the most likely scenarios, most households will end up worse off than had the TCJA never passed. In short, TCJA likely made the current generation of high-income households better off at the expense of lower-income households and future generations.

While the law improved the revenue code in some ways, it falls short on three key dimensions – economic growth, fiscal sustainability, and distributional effects.

A few other features of TCJA are worth noting. First, Congress passed the TCJA at a time when the United States had recovered from the Great Recession. Tax cuts are most useful when they stimulate the economy during times of recession. At a time of full employment and strong corporate profits, however, Congress should have increased taxes to address the long-term fiscal shortfall, not cut them. Second, the new pass-through business deduction and international rules were hastily constructed and create complexity, socially wasteful tax avoidance behavior, and uncertainty. Third, the law will raise the cost of health insurance and reduce coverage.

The future of TCJA remains uncertain. Nearly all of its individual tax changes will expire between now and 2026. Other provisions, such as its pass-through rules and many of the international provisions, may not stand the test of time. What is clear, though, is that TCJA took tax and fiscal policy in the wrong direction.

Gale is codirector of the Urban-Brookings Tax Policy Center and the author of Fiscal Therapy: Curing America’s Debt Addiction and Investing in the Future (Oxford 2019)

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By William G. Gale
Almost one year ago, President Trump signed into law the Tax Cuts and Jobs Act (TCJA), the biggest tax overhaul in the United States in over 30 years. While the law improved the revenue code in some ways, it falls short on three key dimensions – economic growth, fiscal sustainability, and distributional effects.
Among its many changes, TCJA cut the corporate rate tax from 35 percent to 21 percent, redesigned international tax rules, and created a deduction for non-corporate (“pass-through”) business income. It repealed personal exemptions, expanded the standard deduction, eliminated the tax on people who do not obtain adequate health insurance, and greatly weakened the estate tax. Most of the corporate provisions are permanent, while most individual income tax and estate tax provisions (except for health insurance) expire after 2025.
The TCJA will simplify tax filing for those who will now claim the standard deduction instead of itemizing, and some of its corporate tax cuts will create new incentives for investment. Overall, however, the law makes the tax code worse, not better.
Growth: Tax cuts raise long-term growth by improving incentives to work, save, and invest, but the deficits they create will offset some or all of those gains. Most studies indicate that the long-term impact on Gross Domestic Product (GDP) – the output produced in the United States – will be modest. The impact on Gross National Product (GNP) – the income that Americans receive – will be even smaller. Because the TCJA will encourage foreigners to invest in the United States, the returns they receive will reduce the amount of income that Americans will keep from their production. As a result, Americans will receive no increase in net income in 2028 from TCJA. Of course, TCJA stimulated the economy over its first year, but almost any tax cut that put money in people’s pockets would do that.
Fiscal effects: The CBO estimates that TCJA will increase deficits by $1.9 trillion through 2028, even after incorporating the impact of the new law on the economy. If lawmakers make the temporary provisions of TCJA permanent, the long-term effects will be even more dire.
Distributional Effects: TCJA gave most of its benefits to the wealthy and thus increased the inequality of income, which had already been growing for the past four decades. Tax Policy Center (TPC) estimates show that TCJA increased after-tax income in 2018 by 0.4 percent for households in the lowest quintile, compared with 2.9 percent for those in the top quintile, and even more for the top few percent of households.
About 80 percent of taxpayers did receive a direct tax cut from TCJA, but that is not the end of the story. Tax cuts eventually have to be paid for. When Donald Trump said he was giving Americans a tax cut for Christmas, for example, he neglected to add that they (or their children) eventually would receive the bill. It is unclear how TCJA will eventually be financed, but in the most likely scenarios, most households will end up worse off than had the TCJA never passed. In short, TCJA likely made the current generation of high-income households better off at the expense of lower-income households and future generations.
While the law improved the revenue code in some ways, it falls short on three key dimensions – economic growth, fiscal sustainability, and distributional effects.
A few other features of TCJA are worth noting. First, Congress passed the TCJA at a time when the United States had recovered from the Great Recession. Tax cuts are most useful when they stimulate the economy during times of recession. At a time of full employment and strong corporate profits, however, Congress should have increased taxes to address the long-term fiscal shortfall, not cut them. Second, the new pass-through business deduction and international rules were hastily ... By William G. Gale
Almost one year ago, President Trump signed into law the Tax Cuts and Jobs Act (TCJA), the biggest tax overhaul in the United States in over 30 years. While the law improved the revenue code in some ways, it falls short on three ... https://www.brookings.edu/blog/up-front/2018/12/13/the-hutchins-center-explains-federal-budget-basics/The Hutchins Center Explains: Federal budget basicshttp://webfeeds.brookings.edu/~/585598824/0/brookingsrss/topics/fiscalpolicy~The-Hutchins-Center-Explains-Federal-budget-basics/
Thu, 13 Dec 2018 14:00:00 +0000http://www.brookings.edu?p=102831&preview_id=102831

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By Anna Malinovskaya, Louise Sheiner

The federal government spent nearly $4.1 trillion—one out of every five dollars in the U.S. economy—in the fiscal year that ended Sept. 30, 2018. Read on for a glimpse into how the government spent and earned its money in 2018.

Where does the government spend all that money?

About two-thirds of the budget goes to mandatory spending, programs for which the government does not set a spending cap in advance, but, instead, provides specified benefits to everyone who meets the eligibility criteria. For example, once Congress sets the rules for Medicare—the health insurance program for the elderly—the exact amount of spending varies from year to year based on the size of the elderly population and how much or how little they use heath care services.

The other third of federal outlays, discretionary spending, is determined by Congress on an annual basis. Agencies cannot spend more than the sums appropriated by Congress. For example, funding for National Aeronautics and Space Administration (NASA) is discretionary, which means that every year Congress decides how much federal money to authorize it to use—in 2018, $19.5 billion. NASA then has to operate within that budget.

So what programs fall under mandatory spending?

About half of mandatory spending is spending on programs primarily aimed at the elderly. Social Security pays a monthly old-age benefit to those reaching retirement age (minimum 62), whereas Medicare pays for the health care expenses for those 65 and older. Social Security and Medicare also provide benefits to disabled individuals and families of retired, disabled, and deceased workers.

Next up is Medicaid, the health care program for the poor run jointly by the state and federal governments, and income security programs like unemployment insurance and food stamps. “Other mandatory programs” include an array of much smaller programs that range from federal government and military retirees’ benefits to veterans’ pensions. And last but not least, a portion of mandatory spending goes to interest payments on the federal debt.

Why do we spend so much on interest?

The government has borrowed a lot: The federal debt held by the public amounted to slightly over $15 trillion by the end of 2018, a sum equivalent to roughly 76 percent of the U.S. economy. This level of debt is very high by historical standards. The only previous experience with debt this high was at the end of World War II. As a result, a sizable part of the budget goes to pay interest on that debt—in 2018, interest consumed almost 8 percent of all federal spending. This is more than what the federal government spent on unemployment benefits, higher education, food and nutrition assistance programs, and pollution control taken together.

What about the discretionary spending? What does that include?

About half of discretionary spending goes to defense. In 2017, the most recent year for which data is readily available, U.S. defense spending exceeded that of the next seven countries combined. Defense spending by the U.S. accounted for over a third of worldwide defense spending even though the U.S. economy is only about a fifth of the world economy. Yet U.S. defense spending in 2017 was a smaller share of the world’s military spending than in previous years. For example, during the 2001-2011 decade, the U.S. accounted for about 40 percent of world military spending.

The other half of discretionary spending includes everything from space exploration to salaries of folks who answer phones at the Internal Revenue Service: education and employment, transportation, veterans’ healthcare, administration of justice, and other programs as diverse as international affairs, FBI, and housing assistance. International affairs spending, which includes a wide range of activities from international development and humanitarian assistance to international military assistance, accounts for only 1 percent of all federal spending. Spending for education, training, employment, and social services also represents a relatively small share—just 3 percent —reflecting the fact that most public spending on education is at the state and local level.

Where does the government get all this money?

In 2018, federal revenues amounted to $3.3 trillion. Most of that came from individual income taxes (49 percent) and the payroll taxes levied to finance Social Security and Medicare (35 percent).The remainder came from the corporate income tax (7 percent) and a hodgepodge of other taxes (9 percent) including the estate and gift taxes and taxes on alcohol, tobacco and firearms known as excise taxes.

The type of taxes paid varies a lot across the income distribution too. While the bottom half of earners contributed little to revenue in income taxes, they did contribute significantly in payroll taxes. Seventy percent of the income taxes were paid by people with incomes above $200,000 per year. In contrast, over 70 percent of the payroll taxes were paid by people with annual incomes below $200,000.

How does the size of the government in the U.S. compare to that in other advanced economies?

To compare the size of government across countries, it makes sense to examine all levels of government, so as to ensure an apples-to-apples comparison. In 2018, revenues collected by all levels of government in the United States—federal, state, and local—amounted to 26 percent of the size of the U.S. economy. That’s a much smaller share than in most other advanced economies. For instance, total government revenues represented 33 percent in Canada, 37 percent in Germany, and 46 percent in France.

Has the federal government been getting bigger?

Not much. Although federal spending varies from year to year, in response to both business cycles and changes in legislation, the overall trajectory hasn’t shown a strong upward trend over the past 50 years, measured against the size of the economy. For example, outlays were 20.6 percent of the economy in 2018, just a bit higher than the 20.2 percent average over the past 50 years. Similarly, federal revenues were about 16.6 percent of GDP in 2018, a bit lower than the 17.4 percent 50-year average. The difference, of course, is the budget deficit.

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https://www.brookings.edu/wp-content/uploads/2016/06/hutchins_explains_promo-9-e1515091585112.jpg?w=320UncategorizedBy Anna Malinovskaya, Louise Sheiner
The federal government spent nearly $4.1 trillion—one out of every five dollars in the U.S. economy—in the fiscal year that ended Sept. 30, 2018. Read on for a glimpse into how the government spent and earned its money in 2018.
Where does the government spend all that money?
About two-thirds of the budget goes to mandatory spending, programs for which the government does not set a spending cap in advance, but, instead, provides specified benefits to everyone who meets the eligibility criteria. For example, once Congress sets the rules for Medicare—the health insurance program for the elderly—the exact amount of spending varies from year to year based on the size of the elderly population and how much or how little they use heath care services.
The other third of federal outlays, discretionary spending, is determined by Congress on an annual basis. Agencies cannot spend more than the sums appropriated by Congress. For example, funding for National Aeronautics and Space Administration (NASA) is discretionary, which means that every year Congress decides how much federal money to authorize it to use—in 2018, $19.5 billion. NASA then has to operate within that budget.
So what programs fall under mandatory spending?
About half of mandatory spending is spending on programs primarily aimed at the elderly. Social Security pays a monthly old-age benefit to those reaching retirement age (minimum 62), whereas Medicare pays for the health care expenses for those 65 and older. Social Security and Medicare also provide benefits to disabled individuals and families of retired, disabled, and deceased workers.
Next up is Medicaid, the health care program for the poor run jointly by the state and federal governments, and income security programs like unemployment insurance and food stamps. “Other mandatory programs” include an array of much smaller programs that range from federal government and military retirees’ benefits to veterans’ pensions. And last but not least, a portion of mandatory spending goes to interest payments on the federal debt.
Why do we spend so much on interest?
The government has borrowed a lot: The federal debt held by the public amounted to slightly over $15 trillion by the end of 2018, a sum equivalent to roughly 76 percent of the U.S. economy. This level of debt is very high by historical standards. The only previous experience with debt this high was at the end of World War II. As a result, a sizable part of the budget goes to pay interest on that debt—in 2018, interest consumed almost 8 percent of all federal spending. This is more than what the federal government spent on unemployment benefits, higher education, food and nutrition assistance programs, and pollution control taken together.
What about the discretionary spending? What does that include?
About half of discretionary spending goes to defense. In 2017, the most recent year for which data is readily available, U.S. defense spending exceeded that of the next seven countries combined. Defense spending by the U.S. accounted for over a third of worldwide defense spending even though the U.S. economy is only about a fifth of the world economy. Yet U.S. defense spending in 2017 was a smaller share of the world’s military spending than in previous years. For example, during the 2001-2011 decade, the U.S. accounted for about 40 percent of world military spending.
The other half of discretionary spending includes everything from space exploration to salaries of folks who answer phones at the Internal Revenue Service: education and employment, transportation, veterans’ healthcare, administration of justice, and other programs as diverse as international affairs, FBI, and housing assistance. International affairs spending, which includes a wide range of activities from international development and ... By Anna Malinovskaya, Louise Sheiner
The federal government spent nearly $4.1 trillion—one out of every five dollars in the U.S. economy—in the fiscal year that ended Sept. 30, 2018. Read on for a glimpse into how the government ... https://www.brookings.edu/blog/future-development/2018/12/01/trump-and-xi-at-the-g-20-why-bilateralism-wont-work/Trump and Xi at the G-20: Why bilateralism won’t workhttp://webfeeds.brookings.edu/~/583205820/0/brookingsrss/topics/fiscalpolicy~Trump-and-Xi-at-the-G-Why-bilateralism-won%e2%80%99t-work/
Sat, 01 Dec 2018 12:17:06 +0000https://www.brookings.edu/?p=550360

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By Adam Triggs

Ten years ago, G-20 countries displayed an unprecedented level of multilateral cooperation in response to the global financial crisis. How times have changed. This weekend’s G-20 summit in Buenos Aires will look very different. Cooperation has been replaced with confrontation, solidarity with suspicion, and multilateralism with bilateralism.

A big bet on bilateralism

President Trump has made this weekend’s G-20 summit all about his bilateral meeting with Xi Jinping. This is a mistake. Trump’s 1980s are over. The challenges facing the world today, particularly in trade, cannot be solved bilaterally.

Bilateral responses to multilateral problems will—at best—entrench the sort of deadlocks we saw in APEC two weeks ago. At worst, they will legitimize fake solutions that risk permanently damaging the global system.

The G-20 must not allow itself to be sidelined so easily. It must learn the lessons of its past if it is to help the world navigate today’s turbulence. In a new working paper, I remind us of some of these past lessons. The paper analyses the economics and the politics of what was the centerpiece of the G-20’s multilateral cooperation during the crisis: a coordinated fiscal stimulus.

Ten years ago, countries promised to coordinate $5 trillion of fiscal stimulus to stop the Great Recession from becoming another Great Depression. The G-20 not only met this commitment. It exceeded it. From 2008 to 2010, the G-20 delivered $6.4 trillion of fiscal stimulus. But more importantly, the analysis of this period reminds us of two pertinent lessons which should be kept in mind for this weekend’s G-20 summit in Argentina.

Multilateralism is better

The first lesson is that the economic benefits of multilateral cooperation far exceed those from bilateral cooperation. Using a new computable general equilibrium model of the G-20, I show that the first-year GDP benefits from fiscal stimulus are, on average, twice as large when countries work together than when they act alone. For every dollar a country spends on fiscal stimulus, it gets the benefit of an extra dollar for free if other countries stimulate at the same time.

The same principle is true for trade. The benefits from lowering trade barriers are larger when more countries participate. Bilateral free trade deals achieve only a fraction of the benefits from multilateral trade liberalization in the WTO.

The model shows that trade deficits are fundamentally shaped by domestic policy settings, particularly fiscal policy. The U.S. trade deficit cannot be ‘solved’ bilaterally with China. A country (like the United States) that invests more than it saves imports capital from other countries (like China) to finance the investment. This inflow of capital appreciates the U.S. dollar, which reduces exports and increases imports, resulting in a trade deficit.

The U.S. trade deficit simply reflects its capital inflows from countries like China. It reflects the fact that U.S. consumers, firms and the government are borrowing to finance investment and consumption. A trade deal on the weekend in which China agrees to buy more U.S. exports will not change this underlying saving and investment arithmetic and will not, therefore, alter the overall trade balance.

The paper shows that the best way for Trump to reduce the U.S. trade deficit is to rein in his administration’s fiscal spending. Trump’s massive increase in the fiscal deficit, which has done nothing to lift investment or productivity will, by the end of 2018, require a U.S. government bond issuance of $1.34 trillion. If history is any guide, about half of that will have to be financed by foreign investors. My calculation is that this capital inflow will push up the U.S. dollar and worsen the U.S. trade deficit by around 0.6 percent in the first year.

There are issues in the global trading system that Trump has correctly identified as problems. But they cannot be solved bilaterally. They require a multilateral response—for which the G-20 is eminently suited—and include reforming and modernizing the World Trade Organisation and removing barriers to trade in services and digital trade, to name a few.

A strategic asset, not just a speech club

The second lesson from the paper is that the G-20 is a strategic asset. It provides political benefits, if used effectively.

Many query whether the G-20’s fiscal stimulus during the crisis was genuinely coordinated, given countries generally have an incentive to undertake stimulus regardless of what other countries do. To find out, I interviewed multiple politicians and officials from every G-20 country, 63 in total, including Kevin Rudd, Janet Yellen, Joe Hockey, Ben Bernanke, Jack Lew, Haruhiko Kuroda, Mark Carney, Wayne Swan, and 56 equally senior people.

The results were clear. Eleven of the G-20 economies undertook more fiscal stimulus because of the agreement at the G-20. “The G-20 played a positive role in the quantum of Australia’s fiscal stimulus,” said Kevin Rudd, Australia’s 26th Prime Minister. Politicians from ten other countries, usually smaller countries rather than larger ones, said the same thing, verified with data, where possible.

Politicians and officials said that the G-20 helps them to sell policies domestically. It gives them new ideas. It influences their thinking. It generates peer pressure. It helps defeat free-rider concerns and can result in countries being more ambitious in their commitments. It follows that the G-20 can, if used strategically, help its members achieve significant results.

It would be a tragedy if the U.S. and China allow their tactics in Buenos Aires to trump strategy.

]]>
By Adam Triggs
Ten years ago, G-20 countries displayed an unprecedented level of multilateral cooperation in response to the global financial crisis. How times have changed. This weekend’s G-20 summit in Buenos Aires will look very different. Cooperation has been replaced with confrontation, solidarity with suspicion, and multilateralism with bilateralism.
A big bet on bilateralism
President Trump has made this weekend’s G-20 summit all about his bilateral meeting with Xi Jinping. This is a mistake. Trump’s 1980s are over. The challenges facing the world today, particularly in trade, cannot be solved bilaterally.
Bilateral responses to multilateral problems will—at best—entrench the sort of deadlocks we saw in APEC two weeks ago. At worst, they will legitimize fake solutions that risk permanently damaging the global system.
The G-20 must not allow itself to be sidelined so easily. It must learn the lessons of its past if it is to help the world navigate today’s turbulence. In a new working paper, I remind us of some of these past lessons. The paper analyses the economics and the politics of what was the centerpiece of the G-20’s multilateral cooperation during the crisis: a coordinated fiscal stimulus.
Ten years ago, countries promised to coordinate $5 trillion of fiscal stimulus to stop the Great Recession from becoming another Great Depression. The G-20 not only met this commitment. It exceeded it. From 2008 to 2010, the G-20 delivered $6.4 trillion of fiscal stimulus. But more importantly, the analysis of this period reminds us of two pertinent lessons which should be kept in mind for this weekend’s G-20 summit in Argentina.
Multilateralism is better
The first lesson is that the economic benefits of multilateral cooperation far exceed those from bilateral cooperation. Using a new computable general equilibrium model of the G-20, I show that the first-year GDP benefits from fiscal stimulus are, on average, twice as large when countries work together than when they act alone. For every dollar a country spends on fiscal stimulus, it gets the benefit of an extra dollar for free if other countries stimulate at the same time.
The same principle is true for trade. The benefits from lowering trade barriers are larger when more countries participate. Bilateral free trade deals achieve only a fraction of the benefits from multilateral trade liberalization in the WTO.
The model shows that trade deficits are fundamentally shaped by domestic policy settings, particularly fiscal policy. The U.S. trade deficit cannot be ‘solved’ bilaterally with China. A country (like the United States) that invests more than it saves imports capital from other countries (like China) to finance the investment. This inflow of capital appreciates the U.S. dollar, which reduces exports and increases imports, resulting in a trade deficit.
The U.S. trade deficit simply reflects its capital inflows from countries like China. It reflects the fact that U.S. consumers, firms and the government are borrowing to finance investment and consumption. A trade deal on the weekend in which China agrees to buy more U.S. exports will not change this underlying saving and investment arithmetic and will not, therefore, alter the overall trade balance.
The paper shows that the best way for Trump to reduce the U.S. trade deficit is to rein in his administration’s fiscal spending. Trump’s massive increase in the fiscal deficit, which has done nothing to lift investment or productivity will, by the end of 2018, require a U.S. government bond issuance of $1.34 trillion. If history is any guide, about half of that will have to be financed by foreign investors. My calculation is that this capital inflow will push up the U.S. dollar and worsen the U.S. trade deficit by around 0.6 percent in the first year.
There are issues in the global trading system that Trump has ... By Adam Triggs
Ten years ago, G-20 countries displayed an unprecedented level of multilateral cooperation in response to the global financial crisis. How times have changed. This weekend’s G-20 summit in Buenos Aires will look very different.https://www.brookings.edu/interactives/hutchins-center-fiscal-impact-measure/Hutchins Center Fiscal Impact Measurehttp://webfeeds.brookings.edu/~/275899806/0/brookingsrss/topics/fiscalpolicy~Hutchins-Center-Fiscal-Impact-Measure/
Wed, 28 Nov 2018 15:00:15 +0000https://www.brookings.edu/?post_type=interactive&p=364199

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By Eric Abalahin

The Hutchins Center Fiscal Impact Measure shows how much fiscal policy adds to or subtracts from overall economic growth. Use the graph below to explore the total quarterly fiscal impact as well as its components: taxes and spending at the federal, state and local levels. (Methodology »)

TAKEAWAYS FROM THE THIRD QUARTER UPDATE, 11/28/2018

By Louise Sheiner and Sage Belz

The spending and tax policies of federal, state, and local governments added 0.6 percentage point to growth in Gross Domestic Product in the third quarter, fueled by increased spending at all levels of government, according to the latest Hutchins’ Fiscal Impact Measure. Inflation-adjusted GDP rose at a 3½ percent annual rate in the quarter.

Fiscal policies neither added to nor subtracted much from economic growth from 2014 through 2017, but recent federal legislation and increased spending by state and local governments have contributed positively to growth. Local, state and federal fiscal policy have given more of a boost to the economy in 2018 than in any year since the recession-era stimulus in 2010.

Spending at the state and local level grew at a 2 percent annual rate in the quarter. Earlier estimates that showed a robust increase in state and local government investment in the third quarter have been revised downwards, indicating the sector’s impact on growth was smaller than previously estimated. Nonetheless, investment in the sector, which has been weak since the Great Recession, has showed some signs of recovery in the last four quarters. Growth in investment has been shared broadly between intellectual property, structures and equipment. Employment at the state and local level has also picked up over the past four quarters, but remains below its pre-recession levels.

Federal spending rose modestly in the third quarter, mostly the result of higher defense expenditures, and contributed about 0.2 percentage point to GDP growth. Tax cuts enacted at the beginning of 2018 have boosted consumption and added to the pace of growth for the last three quarters, although the latest reading on the FIM suggests their effects on growth may have begun to taper. Transfers at all levels of government rose modestly in the quarter.

Today’s reading shows that the combination of federal, state, and local spending are providing additional stimulus to the economy beyond what is consistent with trend growth.

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By Eric Abalahin
The Hutchins Center Fiscal Impact Measure shows how much fiscal policy adds to or subtracts from overall economic growth. Use the graph below to explore the total quarterly fiscal impact as well as its components: taxes and spending at the federal, state and local levels. (Methodology »)
TAKEAWAYS FROM THE THIRD QUARTER UPDATE, 11/28/2018
By Louise Sheiner and Sage Belz
The spending and tax policies of federal, state, and local governments added 0.6 percentage point to growth in Gross Domestic Product in the third quarter, fueled by increased spending at all levels of government, according to the latest Hutchins’ Fiscal Impact Measure. Inflation-adjusted GDP rose at a 3½ percent annual rate in the quarter.
Fiscal policies neither added to nor subtracted much from economic growth from 2014 through 2017, but recent federal legislation and increased spending by state and local governments have contributed positively to growth. Local, state and federal fiscal policy have given more of a boost to the economy in 2018 than in any year since the recession-era stimulus in 2010.
Spending at the state and local level grew at a 2 percent annual rate in the quarter. Earlier estimates that showed a robust increase in state and local government investment in the third quarter have been revised downwards, indicating the sector’s impact on growth was smaller than previously estimated. Nonetheless, investment in the sector, which has been weak since the Great Recession, has showed some signs of recovery in the last four quarters. Growth in investment has been shared broadly between intellectual property, structures and equipment. Employment at the state and local level has also picked up over the past four quarters, but remains below its pre-recession levels.
Federal spending rose modestly in the third quarter, mostly the result of higher defense expenditures, and contributed about 0.2 percentage point to GDP growth. Tax cuts enacted at the beginning of 2018 have boosted consumption and added to the pace of growth for the last three quarters, although the latest reading on the FIM suggests their effects on growth may have begun to taper. Transfers at all levels of government rose modestly in the quarter.
Today’s reading shows that the combination of federal, state, and local spending are providing additional stimulus to the economy beyond what is consistent with trend growth.
By Eric Abalahin
The Hutchins Center Fiscal Impact Measure shows how much fiscal policy adds to or subtracts from overall economic growth. Use the graph below to explore the total quarterly fiscal impact as well as its components: taxes and ... https://www.brookings.edu/blog/the-avenue/2018/11/27/a-handful-of-ports-and-their-workers-bear-the-brunt-of-retaliatory-tariffs/A handful of ports and their workers bear the brunt of retaliatory tariffshttp://webfeeds.brookings.edu/~/582669096/0/brookingsrss/topics/fiscalpolicy~A-handful-of-ports-and-their-workers-bear-the-brunt-of-retaliatory-tariffs/
Tue, 27 Nov 2018 05:00:17 +0000https://www.brookings.edu/?p=550045

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By Adie Tomer, Joseph Kane

If the country had a dashboard for economic health, most signs would point positive: unemployment down, median wages finally rising, consumer confidence strong.

Yet amid all the good news, fallout from trade tariffs are contributing to rising fears of economic unrest. Every community in the country relies on trade to some degree, putting agricultural exporters, retail importers, and many other industries at risk of higher prices, disrupted supply chains, and a loss of market power.

While trade may touch producers and consumers in every corner of the country, the physical act of international exchange is a highly concentrated activity. Even with hundreds of border crossings, airports, and seaports, only a small group of places process most of the country’s international goods. As a result, these facilities are both essential connections to the world and major economic anchors in their local communities.

The growing trade war now poses a genuine economic threat to this small set of port-focused metro areas. If tariffs depress total trade, these ports could see reductions in business activity—leading to decreased labor hours, rising fiscal challenges, and an overall drag on local economic growth. The urgency is only increasing as China formalizes a third round of tariffs and the Trump administration threatens further retaliatory action.

Using trade volume information from PIERS and the U.S. Census Bureau, plus labor market data from EMSI, we gauged how international tariff adjustments, including those imposed under Section 232 (affecting steel and aluminum imports) and Section 301 (affecting trade of certain products with China), could affect trade and port-related employment in metro areas. Four key findings stand out:

1. In 2017, $221 billion of seaborne cargo was exposed to recently adjusted tariffs, accounting for nearly 10 percent of all goods moved through U.S. seaports that year.

The U.S. is one of the largest seaborne traders in the world, moving over $2.2 trillion in exports and imports across more than 170 different ports in 2017 alone. Like the U.S. as a whole, these seaports also reflect a trade imbalance between imports ($1.3 trillion) and exports ($0.9 trillion).

American consumers have been far more exposed than American exporters to tariff adjustments thus far. Higher retaliatory tariffs only impact $49.5 billion of U.S. seaborne exports, equal to about 5.4 percent of all exported seaborne value in 2017. By contrast, U.S. tariffs expose about $171.7 billion in seaborne imports, or 13.1 percent of all imported seaborne value in 2017.

Some of the major commodities exposed to these tariffs include various plastics, machines, and appliances imported from China (under Section 301), as well as several aluminum and steel products imported from countries ranging from India to Mexico (under Section 232). As international peers respond to escalations in this ongoing trade war, America’s exported commodities will only be hit harder.

2. Tariff impacts are concentrated in a small number of U.S. seaports, with 20 ports absorbing 94 percent of these impacts.

Even with over 170 different seaports across the country, U.S. seaborne trade is highly concentrated in a relatively small number of seaports. Some of this has to do with equipment capacity, exemplified by the container cranes visible in large ports. It also has to do with commodity specialization based on local equipment, like oils and chemicals facilities at Gulf Coast ports or grain elevators in Portland, Ore.

This concentration leads to high levels of tariff exposure in a relatively small number of places: 20 ports spread across 18 metro areas move 94 percent of all commodities that could be impacted by tariffs. The biggest ports face the brunt of these tariffs. Los Angeles, Long Beach, Calif., and New York City combine to move almost 50 percent of all tariff-related commodities by value, and the next seven most-exposed ports move more than another 30 percent of national value.

The geography of total tariff exposure represents a kind of road map to American trade. Our nation’s large appetite for imported consumer goods implicates the California ports and metro Seattle’s two ports. Most Atlantic ports also specialize in various consumer-focused goods. Gulf Coast ports—especially those near Houston, New Orleans, La., and Mobile, Ala.—specialize in commodities like iron, glass, and various machine parts.

3. Many of the largest tariff-exposed ports could see between 10 and 25 percent of their trade volume impacted.

Depending on how businesses and households respond to higher-priced goods, recently adjusted tariffs could affect considerable shares of current activity at many of the country’s largest ports. The three largest California ports—Los Angeles, Long Beach, and Oakland—could all see roughly 20 percent of their trade volumes impacted. Seattle and Tacoma, Wash. have the same level of exposure. Meanwhile, in most of the major east coast ports—including New York; Baltimore; Norfolk, Va.; Charleston, S.C.; and Savannah, Ga.—10 to 17 percent of total trade volume may be affected.

Yet even for some of the country’s smaller seaports, tariff exposures are significant relative to their local operations. For example, over 20 percent of traded value at ports in Chicago and Vancouver, Wash. is in goods impacted by higher tariffs. Operators at these relatively smaller ports are rightly concerned with what tariffs could mean for their business.

4. The trade war leaves the country’s port-related labor force in a tenuous position, with hundreds of thousands of workers carrying out activities that could be reduced or eliminated.

While there is no clear or consistent definition of how many workers are employed across all of the country’s seaports—including related warehousing, trucking, and shipping firms—there are at least 129,000 workers employed directly within seaborne establishments, according to standard industry definitions. Research using broader definitions suggests more than 400,000 workers nationwide are directly employed in activities related to seaborne trade, ranging from business specialists to offsite truck drivers. While it’s difficult to know exactly how many workers directly tie into seaborne trade in any given place, we use local employment figures and this national 1:4 ratio to estimate direct employment exposure.

Overall, port employment mirrors the concentration of trade volumes, meaning a small set of metro areas account for a disproportionate share of jobs directly related to seaborne trade. And since many of those same ports face the highest tariff exposure, their sizable labor forces could bear the brunt of any tariff-induced declines in trade.

Among direct jobs, most locally exposed jobs are in the country’s biggest port metro areas, including almost two-thirds in the 10 largest ports alone. Led by Los Angeles (14 percent), Miami (12 percent), Houston (9 percent), and New York (6 percent), these ports house tens of thousands of laborers, drivers, and operators directly responsible for processing cargo. Nationally, even greater numbers of workers depend directly on the traded commodities that flow through these ports (Table 1).

While today’s trade war is largely driven in Washington, D.C. and reconciled at factories and checkout counters across the country, ports have little defense from becoming collateral damage. They are the backbone of international trade flows, leaving them deeply exposed to international negotiations and market responses outside their control.

That starts with port-related employment. Port jobs are tradable, meaning they sell services to outside markets (both domestic and international) and bring new income into their home metro areas. As such, they’re essential to growing local economies. Any reductions in their employment levels will be felt both by the port-related workers and all the support services they rely on, like local retail industries. In other words: expect drags on local economic output. This makes it all the more important for port leadership, plus public and private economic development staffers, to closely follow what’s happening locally.

There is also a role for state and federal leadership. Trade adjustment programs often look at workers and communities impacted by changing trade patterns. Seaborne trade easily fits that bill, and the geographically-focused impacts mean specific metro areas have a case to receive attention as policymakers consider modernizing such programs. As the trade war continues to evolve and perhaps escalate, policymakers must closely monitor market responses by consumers, producers, and ports to determine who’s paying the economic price, and how best to alleviate it.

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https://www.brookings.edu/wp-content/uploads/2018/11/2018.11.27_metro_tomer-kane_port-tariffs.jpg?w=288By Adie Tomer, Joseph Kane
If the country had a dashboard for economic health, most signs would point positive: unemployment down, median wages finally rising, consumer confidence strong.
Yet amid all the good news, fallout from trade tariffs are contributing to rising fears of economic unrest. Every community in the country relies on trade to some degree, putting agricultural exporters, retail importers, and many other industries at risk of higher prices, disrupted supply chains, and a loss of market power.
While trade may touch producers and consumers in every corner of the country, the physical act of international exchange is a highly concentrated activity. Even with hundreds of border crossings, airports, and seaports, only a small group of places process most of the country’s international goods. As a result, these facilities are both essential connections to the world and major economic anchors in their local communities.
The growing trade war now poses a genuine economic threat to this small set of port-focused metro areas. If tariffs depress total trade, these ports could see reductions in business activity—leading to decreased labor hours, rising fiscal challenges, and an overall drag on local economic growth. The urgency is only increasing as China formalizes a third round of tariffs and the Trump administration threatens further retaliatory action.
Using trade volume information from PIERS and the U.S. Census Bureau, plus labor market data from EMSI, we gauged how international tariff adjustments, including those imposed under Section 232 (affecting steel and aluminum imports) and Section 301 (affecting trade of certain products with China), could affect trade and port-related employment in metro areas. Four key findings stand out:
1. In 2017, $221 billion of seaborne cargo was exposed to recently adjusted tariffs, accounting for nearly 10 percent of all goods moved through U.S. seaports that year.
The U.S. is one of the largest seaborne traders in the world, moving over $2.2 trillion in exports and imports across more than 170 different ports in 2017 alone. Like the U.S. as a whole, these seaports also reflect a trade imbalance between imports ($1.3 trillion) and exports ($0.9 trillion).
American consumers have been far more exposed than American exporters to tariff adjustments thus far. Higher retaliatory tariffs only impact $49.5 billion of U.S. seaborne exports, equal to about 5.4 percent of all exported seaborne value in 2017. By contrast, U.S. tariffs expose about $171.7 billion in seaborne imports, or 13.1 percent of all imported seaborne value in 2017.
Some of the major commodities exposed to these tariffs include various plastics, machines, and appliances imported from China (under Section 301), as well as several aluminum and steel products imported from countries ranging from India to Mexico (under Section 232). As international peers respond to escalations in this ongoing trade war, America’s exported commodities will only be hit harder.
2. Tariff impacts are concentrated in a small number of U.S. seaports, with 20 ports absorbing 94 percent of these impacts.
Even with over 170 different seaports across the country, U.S. seaborne trade is highly concentrated in a relatively small number of seaports. Some of this has to do with equipment capacity, exemplified by the container cranes visible in large ports. It also has to do with commodity specialization based on local equipment, like oils and chemicals facilities at Gulf Coast ports or grain elevators in Portland, Ore.
This concentration leads to high levels of tariff exposure in a relatively small number of places: 20 ports spread across 18 metro areas move 94 percent of all commodities that could be impacted by tariffs. The biggest ports face the brunt of these tariffs. Los Angeles, Long Beach, Calif., and New York City combine to move almost 50 percent of all tariff-related commodities by value, ... By Adie Tomer, Joseph Kane
If the country had a dashboard for economic health, most signs would point positive: unemployment down, median wages finally rising, consumer confidence strong.
Yet amid all the good news, fallout from trade tariffs are ... https://www.brookings.edu/research/optimizing-the-maturity-structure-of-u-s-treasury-debt/Optimizing the maturity structure of U.S. Treasury debt: A model-based frameworkhttp://webfeeds.brookings.edu/~/573982426/0/brookingsrss/topics/fiscalpolicy~Optimizing-the-maturity-structure-of-US-Treasury-debt-A-modelbased-framework/
Wed, 10 Oct 2018 13:52:24 +0000https://www.brookings.edu/?post_type=research&p=538765

The U.S. Treasury doesn’t decide how much money to borrow each year; that depends on the gap between federal spending and revenues. The Treasury does decide how to borrow – that is, how much short-term and how much long-term and how much in between. These decisions typically involve a trade-off between minimizing expected costs of borrowing and minimizing fiscal risks.

For years, the U.S. Treasury has focused primarily on maintaining a “regular and predictable” pattern of debt, while several other countries rely on analytical frameworks or models to guide their decisions. In a paper commissioned by the Hutchins Center on Fiscal and Monetary Policy at Brookings, six Wall Street economists – Terry Belton, Huachen Li, and Srini Ramaswamy of JPMorgan Chase, Kristopher Dawsey and Brian Sack of The D. E. Shaw Group, and David Greenlaw of Morgan Stanley – describe a framework to guide Treasury decisions. Their paper – “Optimizing the Maturity Structure of U.S. Treasury Debt: A Model-Based Framework” – presents a model that can be used to assess the trade-offs between various debt issuance strategies and to explore the sensitivity of those trade-offs to different assumptions.

The model — originally developed by several members of the Treasury Borrowing Advisory Committee, a private-sector panel that advises Treasury debt managers – captures an important trade-off between short-term and long-term financing. In general, the authors write, short-term financing is relatively inexpensive but can complicate budget planning by increasing the volatility of interest expenses. Longer-term borrowing mitigates the volatility of financing costs, but typically at a higher expected cost, because long-term interest rates tend to be higher than shorter-term rates. A debt manager concerned with managing debt-service costs must strike a balance between these competing considerations when determining the optimal issuance profile across all maturities.

The authors demonstrate this trade-off by examining debt management decisions made from 2007 to 2015 that extended the projected weighted average maturity of Treasury debt from six to seven years. Their model shows that this maturity extension increased expected debt service costs, costing the Treasury around $10 billion a year, but reduced the variability of debt service costs.

The model also highlights the potential cost of failing to optimize the maturity structure of debt issuance. For instance, in 2007, the authors say, the Treasury could have reduced its expected debt service costs by just over 0.2 percent of GDP, or about $40 billion per year based on current GDP, without increasing the variation in debt service costs, by following the model’s analytical approach to optimizing the Treasury’s debt structure.

The authors suggest that issuing debt at intermediate maturities – particularly two-, three-, and five-year securities – is appealing, as those securities do not involve high expected costs and yet are effective at smoothing variation of interest expenses over time. Issuing too much on the long end – 10 years and beyond – is particularly unattractive, as this increases debt service costs without reducing variability. However, the exact optimal maturity profile depends on the risk aversion of the issuer. A risk neutral or moderately risk averse debt manager would prefer to skew issuance towards the short end, producing a larger concentration of debt with maturities of five years or less than observed in the current U.S. Treasury debt stock; while a highly risk averse debt manager would choose to issue fewer short-term and more long-term securities.

A debt issuance strategy that responds dynamically to the level of the short-term interest rate, the term premium, and the size of the budget deficit can further improve outcomes. For instance, the model suggests that increases in the term premium and the real two-year rate generally favor moving into short-term bills from medium- and long-term securities, while rising deficits should result in increases in medium-term securities offset by borrowing less at the at the long and short end.

Belton, Greenlaw, and Sack are members of the Treasury Borrowing Advisory Committee — a committee composed of senior representatives from investment funds and banks that meets quarterly with the Treasury Department. This paper was prepared to further discussion of potential changes to the model that informs the U.S. Treasury’s debt management choices. The authors are employees of investment funds and banks, however, they did not receive financial support for their work on this paper.

The authors would like to thank participants from an authors’ workshop held at The Hutchins Center on Fiscal and Monetary Policy at Brookings in May 2018 for their helpful feedback, and Colin Kim for his helpful comments. The authors would also like to thank Jason Cummins for suggesting this project, and Walter Mueller for providing guidance in its early stages. All views expressed in this paper are those of the authors and do not represent the views of JPMorgan Chase, The D. E. Shaw Group, Morgan Stanley, or the Brookings Institution.

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By Terry Belton, Kristopher Dawsey, David Greenlaw, Huachen Li, Srini Ramaswamy, Brian Sack
The U.S. Treasury doesn’t decide how much money to borrow each year; that depends on the gap between federal spending and revenues. The Treasury does decide how to borrow – that is, how much short-term and how much long-term and how much in between. These decisions typically involve a trade-off between minimizing expected costs of borrowing and minimizing fiscal risks.
For years, the U.S. Treasury has focused primarily on maintaining a “regular and predictable” pattern of debt, while several other countries rely on analytical frameworks or models to guide their decisions. In a paper commissioned by the Hutchins Center on Fiscal and Monetary Policy at Brookings, six Wall Street economists – Terry Belton, Huachen Li, and Srini Ramaswamy of JPMorgan Chase, Kristopher Dawsey and Brian Sack of The D. E. Shaw Group, and David Greenlaw of Morgan Stanley – describe a framework to guide Treasury decisions. Their paper – “Optimizing the Maturity Structure of U.S. Treasury Debt: A Model-Based Framework” – presents a model that can be used to assess the trade-offs between various debt issuance strategies and to explore the sensitivity of those trade-offs to different assumptions.
The model — originally developed by several members of the Treasury Borrowing Advisory Committee, a private-sector panel that advises Treasury debt managers – captures an important trade-off between short-term and long-term financing. In general, the authors write, short-term financing is relatively inexpensive but can complicate budget planning by increasing the volatility of interest expenses. Longer-term borrowing mitigates the volatility of financing costs, but typically at a higher expected cost, because long-term interest rates tend to be higher than shorter-term rates. A debt manager concerned with managing debt-service costs must strike a balance between these competing considerations when determining the optimal issuance profile across all maturities.
The authors demonstrate this trade-off by examining debt management decisions made from 2007 to 2015 that extended the projected weighted average maturity of Treasury debt from six to seven years. Their model shows that this maturity extension increased expected debt service costs, costing the Treasury around $10 billion a year, but reduced the variability of debt service costs.
The model also highlights the potential cost of failing to optimize the maturity structure of debt issuance. For instance, in 2007, the authors say, the Treasury could have reduced its expected debt service costs by just over 0.2 percent of GDP, or about $40 billion per year based on current GDP, without increasing the variation in debt service costs, by following the model’s analytical approach to optimizing the Treasury’s debt structure.
The authors suggest that issuing debt at intermediate maturities – particularly two-, three-, and five-year securities – is appealing, as those securities do not involve high expected costs and yet are effective at smoothing variation of interest expenses over time. Issuing too much on the long end – 10 years and beyond – is particularly unattractive, as this increases debt service costs without reducing variability. However, the exact optimal maturity profile depends on the risk aversion of the issuer. A risk neutral or moderately risk averse debt manager would prefer to skew issuance towards the short end, producing a larger concentration of debt with maturities of five years or less than observed in the current U.S. Treasury debt stock; while a highly risk averse debt manager would choose to issue fewer short-term and more long-term securities.
A debt issuance strategy that responds dynamically to the level of the short-term interest rate, ... By Terry Belton, Kristopher Dawsey, David Greenlaw, Huachen Li, Srini Ramaswamy, Brian Sack
The U.S. Treasury doesn’t decide how much money to borrow each year; that depends on the gap between federal spending and revenues.https://www.brookings.edu/blog/ben-bernanke/2018/09/21/the-housing-bubble-the-credit-crunch-and-the-great-recession-reply-to-paul-krugman/The housing bubble, the credit crunch, and the Great Recession: A reply to Paul Krugmanhttp://webfeeds.brookings.edu/~/570815610/0/brookingsrss/topics/fiscalpolicy~The-housing-bubble-the-credit-crunch-and-the-Great-Recession-A-reply-to-Paul-Krugman/
Fri, 21 Sep 2018 19:01:26 +0000https://www.brookings.edu/?p=538339

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By Ben S. Bernanke

Why was the Great Recession so deep? Certainly, the collapse of the housing bubble was the key precipitating event; falling house prices depressed consumer wealth and spending while leading to sharp reductions in residential construction. However, as I argue in a new paper and blog post, the most damaging aspect of the unwinding bubble was that it ultimately touched off a broad-based financial panic, including runs on wholesale funding and indiscriminate fire sales of even non-mortgage credit. The panic in turn choked off credit supply, pushing the economy into a much more severe decline than otherwise would have occurred. My evidence for this claim is that indicators of panic, including the sharp increases in funding costs for financial institutions and the spiking yields on securitized non-mortgage assets, are strikingly better predictors of the timing and depth of the recession than are housing-related variables such as house prices, market pricing of subprime mortgages, or mortgage delinquency rates.

In a recent post, Paul Krugman gave his take on the causes of the Great Recession. His inclination, contrary to my findings, is to emphasize the effects of the housing bust on aggregate demand rather than the financial panic as the source of the downturn. In a follow-up response to my paper, Krugman asks for evidence on the transmission mechanism. Specifically, if the financial disruption was the major cause of the recession, how were its effects reflected in the major components of GDP, such as consumption and investment? In this post I’ll offer a few thoughts on Paul’s questions.

I’ll start with some observations on the transmission mechanism. Certainly, a reduction in credit supply will affect normally credit-sensitive components of spending, like capital investment, as Krugman notes. But a broad-based and violent financial panic, like the one that gripped the country a decade ago, will also affect the behavior of even firms and households not currently seeking new loans. For example, in a panic, any firm that relies on credit to finance its ongoing operations (such as major corporations that rely on commercial paper) or that might need credit in the near future will face strong incentives to conserve cash and increase precautionary savings. For many firms, the fastest way to cut costs is to lay off workers, rather than to hoard labor and build inventories in the face of slowing demand, as they might normally do. That appears to be what happened: Job losses, which averaged 120,000 per month from the beginning of the recession in December 2007 through August 2008, accelerated to 670,000 per month from September 2008 through March 2009, the period of most intense panic. The unemployment rate, which—despite the fact that house prices had been falling for more than two years — was still around 6 percent in September 2008, shot up almost 4 percentage points over the next year. These are not small effects. Workers, in turn, having been laid off or knowing that they might be, and expecting a lack of access to credit, would likewise have had every incentive to reduce spending and to try to build up cash buffers. Indeed, research has found significant increases in precautionary savings during the financial crisis for both households and firms. In Krugman’s preferred IS-LM terminology, the panic induced a large downward shift in the IS curve.

Although isolating the effects of the credit shock on individual spending components is difficult, it’s nevertheless interesting to follow Krugman and examine how key components of GDP behaved during the recession. The chart below shows real residential investment and real GDP (all data below are quarterly, at annualized growth rates) for the period 2006-2009. As Krugman points out, there were large declines in residential investment in 2006-2007, prior to the major disruptions in financial markets. That’s consistent with his “housing bust” theory of the recession. However, note two points. First, despite the decline in residential investment in 2006-07, real GDP growth remained positive until the first quarter of 2008 and declined only very slightly over the first three quarters of that year, giving little hint of what was to come. However, after the crisis intensified in August/September 2008, GDP fell at annual rates of 8.4 percent in the fourth quarter of 2008 and 4.4 percent in the first quarter of 2009. That precipitous decline ended and began to reverse only as the panic was controlled in the spring of 2009.

Second, the pattern of residential investment was itself evidently affected by the panic, accelerating its pace of decline to a remarkable -34 percent at an annual rate in the fourth quarter of 2008 and -33 percent in the first quarter of 2009, before stabilizing in the second half of 2009 as the panic subsided. That the panic would affect the pace of homebuilding makes intuitive sense, given the reliance on credit of both construction companies and homebuyers. Indeed, my research finds that housing-related indicators like house prices and subprime mortgage valuations predict housing starts reasonably well through 2007, but that after that, indicators of financial panic, including the yields on non-mortgage credit, are actually better predictors of housing activity. In short, absent the panic, the pace and extent of the decline in the housing sector might itself not have been as severe.

The next chart shows the growth of nonresidential fixed business investment, whose behavior Krugman also cites in favor of the housing bust view. But here again, the timing is key to the interpretation. Unlike residential investment, which began contracting early in 2006, business investment did not start to decline until well after the bursting of the housing bubble. From the start of 2006 through the third quarter of 2007, as house prices fell, nonresidential fixed investment growth averaged almost 8 percent, in line with or even above pre-crisis norms. From the beginning of the recession in the fourth quarter of 2007 to the third quarter of 2008, average investment growth was slow but positive. However, from the fourth quarter of 2008, when the panic became intense, through the end of the recession in mid-2009, the rate of business investment growth fell precipitously, to an average annualized rate of -20 percent. Essentially all the decline of business investment took place during the period of most intense panic.

The next two charts show the growth of (1) real personal consumption expenditures for durable goods and (2) the components of the US trade balance. As with business investment, the worst declines in these series took place during the period of extreme panic. In particular, consumer durables spending remained healthy throughout 2006 and 2007, despite declining house prices and home construction. However, in the fourth quarter of 2008, durables spending declined at a 26 percent annual rate, recovering in early 2009 as the panic ended. Likewise, over the fourth quarter of 2008 and the first quarter of 2009, real exports and real imports both fell at average annualized rates of close to 24 percent, as global trade contracted sharply.

Because both exports and imports fell, the net contribution of trade to U.S. aggregate demand was modest. The behavior of the components of trade shown in the figure is nevertheless interesting for this discussion. Trade is particularly credit-sensitive, because importers and exporters rely on trade finance and because a significant portion of trade is in durables, a credit-sensitive category. The collapse of trade in late 2008 and early 2009 is therefore a reasonably good signal of disruptions in credit supply. Likewise, improvements in trade in 2009 likely reflected policies that ended the panic. Expanding on the international theme, note also that the global financial crisis can explain, in a way that the U.S. housing bubble cannot, the depth and synchronization of the worldwide recession of 2008-2009. (See for example, recent analysis by the Bank of England.)

To be clear, none of this disputes that the housing bubble and its unwinding was an essential cause of the recession. Besides their direct effects on demand, the problems in housing and mortgage markets provided the spark that ignited the panic; and the slow recovery from the initial downturn likely was due in part to deleveraging by households and firms exposed to the housing sector.[1] Indeed, my own past research argues that factors related to balance sheet deleveraging and the so-called financial accelerator can have important effects on the pace of economic growth. I do claim, though, that if the financial system had been strong enough to absorb the collapse of the housing bubble without falling into panic, the Great Recession would have been significantly less great. By the same token, if the panic had not been contained by a forceful government response, the economic costs would have been much greater.

One more piece of evidence on this point comes from contemporaneous macroeconomic forecasts. Forecasts made in 2008, by both government agencies and private forecasters, typically incorporated severe declines in house prices and construction among their assumptions but still did not anticipate the severity of the downturn. For example, as discussed in a recent paper by Don Kohn and Brian Sack, the Fed staff’s August 2008 Greenbook report included economic forecasts under a “severe financial stress scenario.” Among the assumptions of this conditional forecast were that house prices would decline by an additional 10 percent relative to baseline forecasts (which had already incorporated significant declines). As a result, the assumed declines in house prices in this projection were close to those that actually would occur. However, even with these assumptions, Fed economists predicted that the unemployment rate would peak at only 6.7 percent, compared to its actual peak of around 10 percent in the fall of 2009. This conditional forecast would have taken full account of a sharp expected decline in housing construction and the wealth effects of falling house prices. The fact that forecasts still badly underestimated the rise in unemployment and the depth of the downturn suggests that some other factors—the financial panic, in my view — would play an important role in the contraction.

The failure of conventional economic models to forecast the effects of the financial panic relates to another point made by Krugman in a more recent post, in which he argues that the experience of the crisis and the Great Recession validates traditional macroeconomics. On many counts—such as the prediction that the Fed’s monetary policies would not be inflationary — I did and still do agree with him. However, as I discuss in my paper, current macro models still do not adequately account for the effects of credit-market conditions or financial instability on real activity. It’s an area where much more work is needed.

[1] Other factors likely contributed to the slow recovery, including the attenuated fiscal response and the constraints put on monetary policy by the zero lower bound on nominal interest rates.

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https://www.brookings.edu/wp-content/uploads/2018/09/RTR2PMB9.jpg?w=243By Ben S. Bernanke
Why was the Great Recession so deep? Certainly, the collapse of the housing bubble was the key precipitating event; falling house prices depressed consumer wealth and spending while leading to sharp reductions in residential construction. However, as I argue in a new paper and blog post, the most damaging aspect of the unwinding bubble was that it ultimately touched off a broad-based financial panic, including runs on wholesale funding and indiscriminate fire sales of even non-mortgage credit. The panic in turn choked off credit supply, pushing the economy into a much more severe decline than otherwise would have occurred. My evidence for this claim is that indicators of panic, including the sharp increases in funding costs for financial institutions and the spiking yields on securitized non-mortgage assets, are strikingly better predictors of the timing and depth of the recession than are housing-related variables such as house prices, market pricing of subprime mortgages, or mortgage delinquency rates.
In a recent post, Paul Krugman gave his take on the causes of the Great Recession. His inclination, contrary to my findings, is to emphasize the effects of the housing bust on aggregate demand rather than the financial panic as the source of the downturn. In a follow-up response to my paper, Krugman asks for evidence on the transmission mechanism. Specifically, if the financial disruption was the major cause of the recession, how were its effects reflected in the major components of GDP, such as consumption and investment? In this post I’ll offer a few thoughts on Paul’s questions.
I’ll start with some observations on the transmission mechanism. Certainly, a reduction in credit supply will affect normally credit-sensitive components of spending, like capital investment, as Krugman notes. But a broad-based and violent financial panic, like the one that gripped the country a decade ago, will also affect the behavior of even firms and households not currently seeking new loans. For example, in a panic, any firm that relies on credit to finance its ongoing operations (such as major corporations that rely on commercial paper) or that might need credit in the near future will face strong incentives to conserve cash and increase precautionary savings. For many firms, the fastest way to cut costs is to lay off workers, rather than to hoard labor and build inventories in the face of slowing demand, as they might normally do. That appears to be what happened: Job losses, which averaged 120,000 per month from the beginning of the recession in December 2007 through August 2008, accelerated to 670,000 per month from September 2008 through March 2009, the period of most intense panic. The unemployment rate, which—despite the fact that house prices had been falling for more than two years — was still around 6 percent in September 2008, shot up almost 4 percentage points over the next year. These are not small effects. Workers, in turn, having been laid off or knowing that they might be, and expecting a lack of access to credit, would likewise have had every incentive to reduce spending and to try to build up cash buffers. Indeed, research has found significant increases in precautionary savings during the financial crisis for both households and firms. In Krugman’s preferred IS-LM terminology, the panic induced a large downward shift in the IS curve.
Although isolating the effects of the credit shock on individual spending components is difficult, it’s nevertheless interesting to follow Krugman and examine how key components of GDP behaved during the recession. The chart below shows real residential investment and real GDP (all data below are quarterly, at annualized growth rates) for the period 2006-2009. As Krugman points out, there were large declines in residential investment in 2006-2007, prior to the major disruptions in financial markets. That’s ... By Ben S. Bernanke
Why was the Great Recession so deep? Certainly, the collapse of the housing bubble was the key precipitating event; falling house prices depressed consumer wealth and spending while leading to sharp reductions in residential ... https://www.brookings.edu/blog/up-front/2018/09/19/reflections-by-bernanke-geithner-and-paulson/Ten years after the financial crisis: Reflections by Bernanke, Geithner and Paulsonhttp://webfeeds.brookings.edu/~/570442940/0/brookingsrss/topics/fiscalpolicy~Ten-years-after-the-financial-crisis-Reflections-by-Bernanke-Geithner-and-Paulson/
Wed, 19 Sep 2018 14:32:19 +0000https://www.brookings.edu/?p=537865

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By Jeffrey Cheng, David Wessel

Ten years after Lehman Brothers’ bankruptcy, former Federal Reserve Chairman Ben Bernanke, former New York Fed President and Treasury Secretary Tim Geithner, and former Treasury Secretary Hank Paulson reflect on the responses they led to the 2007-09 global financial crisis and ensuing Great Recession. Here are highlights of their wide-ranging conversation with Andrew Ross Sorkin of the New York Times and CNBC, hosted by the Hutchins Center on Fiscal and Monetary Policy at the Brookings Institution and the Yale Program on Financial Stability. (You can watch the whole 90-minute interview here.)

Memories of the Financial Crisis

Tim Geithner on the hardest moment of the financial crisis

Asked to recall the worst moment of the crisis, Geithner recalled sitting at breakfast with his wife as she read about what had been done the day before and seeing a mix of despair and doubt on her face.

Ben Bernanke gives his bottom line on the government response to the financial crisis

Bernanke says, in hindsight, the government’s response was late, but proved to be successful even though it remains unpopular.

Why didn’t you do things differently?

Hank Paulson on executive compensation

Paulson says that the government couldn’t force banks to take taxpayer-funded capital in October 2008 so it had to make the terms attractive, which is why he didn’t put limits on bankers’ bonuses.

Tim Geithner on whether there’s an opportunity to do any of the crisis response differently

Geithner says that if the U.S. government had waited until there was no option but to nationalize some big banks, it could have attached more strings. Acting earlier so the banks could remain in private hands was economically sound, but politically treacherous.

Tim Geithner on what the Fed can do

Geithner observes that people think the Fed has more power than it actually does. He says there is “a lot of magical thinking about what central banks can do.”

Why didn’t you save Lehman?

Ben Bernanke on the Lehman Brothers failure

Bernanke argues that lending to Lehman was not only beyond the Fed’s legal authority, but also wasn’t feasible.

Tim Geithner on the Lehman Brothers failure

Geithner recalls that some people were initially relieved when the authorities didn’t save Lehman, but he saw it as evidence that the crisis had outstripped the Fed’s power to contain it. They were unable to prevent Lehman from failing.

Hank Paulson on communication during a crisis

Paulson explains why he wasn’t more forthcoming the day Lehman failed. Had he acknowledged the limits of the government’s ability to intervene, Morgan Stanley would have collapsed immediately.

Did the Fed’s asset purchases known as Quantititive Easing create inequality?

Ben Bernanke on quantitative easing’s effects on inequality

Bernanke challenges the hedge fund managers, among others, who argue that the Fed’s QE is responsible for widening inequality in the U.S.

]]>
By Jeffrey Cheng, David Wessel
Ten years after Lehman Brothers’ bankruptcy, former Federal Reserve Chairman Ben Bernanke, former New York Fed President and Treasury Secretary Tim Geithner, and former Treasury Secretary Hank Paulson reflect on the responses they led to the 2007-09 global financial crisis and ensuing Great Recession. Here are highlights of their wide-ranging conversation with Andrew Ross Sorkin of the New York Times and CNBC, hosted by the Hutchins Center on Fiscal and Monetary Policy at the Brookings Institution and the Yale Program on Financial Stability. (You can watch the whole 90-minute interview here.)
Memories of the Financial Crisis
Tim Geithner on the hardest moment of the financial crisis
Asked to recall the worst moment of the crisis, Geithner recalled sitting at breakfast with his wife as she read about what had been done the day before and seeing a mix of despair and doubt on her face.
Ben Bernanke gives his bottom line on the government response to the financial crisis
Bernanke says, in hindsight, the government’s response was late, but proved to be successful even though it remains unpopular.
Why didn’t you do things differently?
Hank Paulson on executive compensation
Paulson says that the government couldn’t force banks to take taxpayer-funded capital in October 2008 so it had to make the terms attractive, which is why he didn’t put limits on bankers’ bonuses.
Tim Geithner on whether there’s an opportunity to do any of the crisis response differently
Geithner says that if the U.S. government had waited until there was no option but to nationalize some big banks, it could have attached more strings. Acting earlier so the banks could remain in private hands was economically sound, but politically treacherous.
Tim Geithner on what the Fed can do
Geithner observes that people think the Fed has more power than it actually does. He says there is “a lot of magical thinking about what central banks can do.”
Why didn’t you save Lehman?
Ben Bernanke on the Lehman Brothers failure
Bernanke argues that lending to Lehman was not only beyond the Fed’s legal authority, but also wasn’t feasible.
Tim Geithner on the Lehman Brothers failure
Geithner recalls that some people were initially relieved when the authorities didn’t save Lehman, but he saw it as evidence that the crisis had outstripped the Fed’s power to contain it. They were unable to prevent Lehman from failing.
Hank Paulson on communication during a crisis
Paulson explains why he wasn’t more forthcoming the day Lehman failed. Had he acknowledged the limits of the government’s ability to intervene, Morgan Stanley would have collapsed immediately.
Did the Fed’s asset purchases known as Quantititive Easing create inequality?
Ben Bernanke on quantitative easing’s effects on inequality
Bernanke challenges the hedge fund managers, among others, who argue that the Fed’s QE is responsible for widening inequality in the U.S.
By Jeffrey Cheng, David Wessel
Ten years after Lehman Brothers’ bankruptcy, former Federal Reserve Chairman Ben Bernanke, former New York Fed President and Treasury Secretary Tim Geithner, and former Treasury Secretary Hank Paulson reflect ... https://www.brookings.edu/blog/the-avenue/2018/09/19/opportunity-zones-and-shared-prosperity-emerging-principles-from-cleveland/Opportunity Zones and shared prosperity: Emerging principles from Clevelandhttp://webfeeds.brookings.edu/~/570430668/0/brookingsrss/topics/fiscalpolicy~Opportunity-Zones-and-shared-prosperity-Emerging-principles-from-Cleveland/
Wed, 19 Sep 2018 13:09:35 +0000https://www.brookings.edu/?p=537770

Yet those leaders face an important challenge: how can they ensure that private funds deliver sustainable investment in lower-income communities that truly need it, rather than simply accelerate real estate development in neighborhoods where market forces are already strong?

While cities await further guidance from the U.S. Department of Treasury—a crucial step in determining how the Zones actually function—a group of community leaders in Cleveland recently convened to address these questions. Organized as part of the Shared Prosperity Partnership, a national collaboration between the Kresge Foundation, Brookings, the Urban Institute, and Living Cities, the discussion drew on national and local expertise in community and economic development and finance. The discussion highlighted three principles that can inform cities’ efforts to use Opportunity Zones to spur equitable community revitalization:

Intentionality is essential.

As one participant noted, one reason Opportunity Zones have generated so much excitement is that they represent a major new community development tool. Private investors can receive tax breaks by investing unrealized capital gains in Opportunity Funds that, in turn, may back a wide range of projects in low-income neighborhoods. On balance, investors will seek projects that provide higher projected rates of financial return. And states have typically designated a range of neighborhoods as Opportunity Zones, many of which are already benefiting from significant investment activity. In Cleveland, for example, the typical home value in Opportunity Zone communities ranges from just $52,000 in the Opportunity Corridor, to $137,000 in Ohio City/Tremont/West 25th Corridor. As one expert noted, this dynamic could lead to just 10 to 15 percent of the “hottest” Opportunity Zones capturing the lion’s share of investment. Preventing this outcome, and ensuring that Opportunity Zones deliver a social benefit commensurate with the revenues that the U.S. Treasury foregoes, won’t happen by chance.

Public sector and economic development leaders have tools to promote good outcomes.

Over the course of 2018, city leaders have worked with their governors to designate Opportunity Zones, and collaborated with peers to strategize about how best to harness the program. As Opportunity Zones are implemented, those leaders can deploy additional tools to help channel investments toward economically and racially equitable outcomes. For instance, they can: develop marketing prospectuses that identify priority neighborhood investments; layer other public investments and supports to incentivize and leverage Opportunity Zone investment; use permitting and zoning powers as carrots and sticks to encourage desired outcomes; and organize Opportunity Funds themselves that aggregate capital for investment opportunities that could drive more equitable outcomes. All of these strategies might focus on steering investment to more economically challenged Opportunity Zones, equity for small businesses, or industrial real estate development that generates high-quality, accessible jobs for community residents.

They can’t go it alone.

Engaging a broader coalition beyond traditional public sector and economic development actors is critical to achieving inclusive outcomes. The Kresge Foundation and the Rockefeller Foundation have announced a joint effort that, through grants and guarantees, aims to support Opportunity Funds committed to truly inclusive economic development. In this way, philanthropy can help provide patient capital and create more of the certainty needed to unlock private investment. Community organizations and their allies, meanwhile, are uniquely positioned to identify and market neighborhood assets. Their engagement can help shift narratives and assumptions about investment viability, helping to develop a compelling case to fund managers (particularly at large financial institutions) who will influence large capital flows. A broader array of community and national partners could also help shape metrics and drive greater transparency around Opportunity Fund activities to ensure more equitable investment.

Whether Opportunity Zones succeed in creating real opportunity will likely rely less on the goodwill of private investors, and more on the ability and dedication of local actors to focus and harness their investments in ways that support and sustain inclusive growth in diverse, low-income communities. As a city with the organizational know-how, commitment, and imperative to achieve true equity through this new program, Cleveland bears watching.

The Kresge Foundation provides financial support to the Brookings Metropolitan Policy Program.

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By Rachel Barker, Alan Berube
Since their enactment in the 2017 Tax Cuts and Jobs Act, Opportunity Zones have attracted significant interest as a potential major source of untapped capital to revitalize America’s struggling neighborhoods and communities. A growing number of local leaders are eager to turn this buzz into investment that delivers economically inclusive and racially equitable outcomes.
Yet those leaders face an important challenge: how can they ensure that private funds deliver sustainable investment in lower-income communities that truly need it, rather than simply accelerate real estate development in neighborhoods where market forces are already strong?
While cities await further guidance from the U.S. Department of Treasury—a crucial step in determining how the Zones actually function—a group of community leaders in Cleveland recently convened to address these questions. Organized as part of the Shared Prosperity Partnership, a national collaboration between the Kresge Foundation, Brookings, the Urban Institute, and Living Cities, the discussion drew on national and local expertise in community and economic development and finance. The discussion highlighted three principles that can inform cities’ efforts to use Opportunity Zones to spur equitable community revitalization:
Intentionality is essential.
As one participant noted, one reason Opportunity Zones have generated so much excitement is that they represent a major new community development tool. Private investors can receive tax breaks by investing unrealized capital gains in Opportunity Funds that, in turn, may back a wide range of projects in low-income neighborhoods. On balance, investors will seek projects that provide higher projected rates of financial return. And states have typically designated a range of neighborhoods as Opportunity Zones, many of which are already benefiting from significant investment activity. In Cleveland, for example, the typical home value in Opportunity Zone communities ranges from just $52,000 in the Opportunity Corridor, to $137,000 in Ohio City/Tremont/West 25th Corridor. As one expert noted, this dynamic could lead to just 10 to 15 percent of the “hottest” Opportunity Zones capturing the lion’s share of investment. Preventing this outcome, and ensuring that Opportunity Zones deliver a social benefit commensurate with the revenues that the U.S. Treasury foregoes, won’t happen by chance.
Public sector and economic development leaders have tools to promote good outcomes.
Over the course of 2018, city leaders have worked with their governors to designate Opportunity Zones, and collaborated with peers to strategize about how best to harness the program. As Opportunity Zones are implemented, those leaders can deploy additional tools to help channel investments toward economically and racially equitable outcomes. For instance, they can: develop marketing prospectuses that identify priority neighborhood investments; layer other public investments and supports to incentivize and leverage Opportunity Zone investment; use permitting and zoning powers as carrots and sticks to encourage desired outcomes; and organize Opportunity Funds themselves that aggregate capital for investment opportunities that could drive more equitable outcomes. All of these strategies might focus on steering investment to more economically challenged Opportunity Zones, equity for small businesses, or industrial real estate development that generates high-quality, accessible jobs for community residents.
They can’t go it alone.
Engaging a broader coalition beyond traditional public sector and economic development actors is critical to achieving inclusive outcomes. The Kresge Foundation and the Rockefeller Foundation have announced a joint effort that, through grants and guarantees, aims to support Opportunity Funds committed to truly inclusive economic development. In this ... By Rachel Barker, Alan Berube
Since their enactment in the 2017 Tax Cuts and Jobs Act, Opportunity Zones have attracted significant interest as a potential major source of untapped capital to revitalize America’s struggling neighborhoods and ... https://www.brookings.edu/blog/up-front/2018/09/13/eight-lessons-for-fighting-the-next-financial-crisis/Eight lessons for fighting the next financial crisishttp://webfeeds.brookings.edu/~/569481256/0/brookingsrss/topics/fiscalpolicy~Eight-lessons-for-fighting-the-next-financial-crisis/
Thu, 13 Sep 2018 15:11:14 +0000https://www.brookings.edu/?p=536959

]]>
By Nellie Liang

This week at Brookings, the Hutchins Center on Fiscal and Monetary Policy and the Yale Program on Financial Stability gathered dozens of experts who, ten years ago, were on the front lines of the government’s response to the global financial crisis. Their mission was to record the decisions that were made on the myriad of responses to the crisis and the reasons behind those decisions. Although the final product won’t be published for some time, we’ve posted working drafts of several of the papers available on the Brookings website here.

In our paper, Meg McConnell (at the New York Federal Reserve Bank); Phillip Swagel (now at the University of Maryland, a veteran of the Paulson Treasury), and I (now at Brookings, formerly on the staff of the Federal Reserve Board), sum up the outcomes on financial markets and on the real economy of all the actions taken. The totality of the evidence suggests that the interventions, though far from perfect, prevented a second Great Depression. Research on the individual actions taken show they were effective in that they moved key outcome measures, such as risk spreads, and ultimately credit, output, and employment, in the desired direction. However, while the economy performed substantially better than might be expected based on previous financial crises, the actions were not able to prevent a severe recession and a weak recovery.

Financial crises are damaging to growth and employment. We draw eight lessons for future crisis fighters to help to reduce their economic costs:

LESSON 1: A strong regulatory and supervisory structure is necessary to reduce the costs of a crisis on the real economy.

The US regulatory and supervisory structure was weak and not well-matched to the risks in the financial system, which had grown rapidly outside of commercial banks prior to the crisis. It also did not have a viable bankruptcy or resolution process that would allow large and complex financial firms to fail in an orderly way that would minimize damage to the economy. The regulatory and supervisory structure needs to be kept up-to-date with changes in the financial system, and to make it more resilient to a wider range of shocks.

LESSON 2: A strong regulatory and supervisory structure is not a substitute for strong crisis management capabilities.

While a more stringent regime is now in place in the US and in many other jurisdictions, no regime, no matter how well designed, will be able to prevent a financial crisis from occurring ever again. By reflecting on the lessons from the responses to past crises, governments will be better prepared to respond more effectively when faced with the next crisis.

LESSON 3: Prepare (at least) for what is likely.

Understand that the causes and manifestations of future crises will likely differ from those of this crisis, but prepare for a few conditions that are likely to be present in any financial crisis. These include sudden and sustained reductions in liquidity in financial markets, widespread loss of confidence in the adequacy of financial institution capital even if they comply with regulatory standards, and the potential for abrupt failures of financial institutions that could seriously disrupt credit and growth. Authorities should practice responses to manifestations of these common types of conditions.

LESSON 4: Prepare to be surprised.

Recognize the limits of real-time information and inherent ambiguity and unpredictability associated with navigating effectively in crisis situations. Organizations should develop the capacity for rapid innovation, experimentation, and learning.

Communicate with the public on an ongoing basis about the role that the financial system plays in the economy and the principles that will guide policy actions in a crisis. Communication alone cannot deliver concrete outcomes in terms of economic performance or financial system functioning, but it can help to increase the public’s understanding of the rationale for the types of policy actions taken in a crisis.

LESSON 6: There will always be forces that push against early intervention.

Accept that there will always be a variety of forces—including uncertainty, valid concerns about triggering unintended consequences, and gaps in legal authority—that will come together to favor inaction over action until conditions become sufficiently dire. In other words, many of the actions we judge ex post as having come too late will have been seen by many decision-makers in real-time as having come precisely when, and not before, conditions warranted.

LESSON 7: “Late” intervention limits the potential for good outcomes.

Recognize that once conditions become sufficiently extreme or dire, even good decisions and well-executed actions may not yield “good” outcomes, particularly on the macro front, because the extreme conditions themselves have often already laid the groundwork for a deeper economic downturn. One of the hallmarks of decision-making in a financial crisis may be that even the best decisions are likely to yield outcomes that would be viewed as weak or lackluster during normal times.

LESSON 8: “Late” intervention may raise rather than lower the potential for unintended consequences.

Recognize that once conditions have eroded sufficiently, the range of policy options shrinks. Late intervention may necessitate more extreme actions and more substantial deviation from the public’s expectations. These actions may also engender in the public a greater sense of unfairness.

]]>
By Nellie Liang
This week at Brookings, the Hutchins Center on Fiscal and Monetary Policy and the Yale Program on Financial Stability gathered dozens of experts who, ten years ago, were on the front lines of the government’s response to the global financial crisis. Their mission was to record the decisions that were made on the myriad of responses to the crisis and the reasons behind those decisions. Although the final product won’t be published for some time, we’ve posted working drafts of several of the papers available on the Brookings website here.
In our paper, Meg McConnell (at the New York Federal Reserve Bank); Phillip Swagel (now at the University of Maryland, a veteran of the Paulson Treasury), and I (now at Brookings, formerly on the staff of the Federal Reserve Board), sum up the outcomes on financial markets and on the real economy of all the actions taken. The totality of the evidence suggests that the interventions, though far from perfect, prevented a second Great Depression. Research on the individual actions taken show they were effective in that they moved key outcome measures, such as risk spreads, and ultimately credit, output, and employment, in the desired direction. However, while the economy performed substantially better than might be expected based on previous financial crises, the actions were not able to prevent a severe recession and a weak recovery.
Financial crises are damaging to growth and employment. We draw eight lessons for future crisis fighters to help to reduce their economic costs:
LESSON 1: A strong regulatory and supervisory structure is necessary to reduce the costs of a crisis on the real economy.
The US regulatory and supervisory structure was weak and not well-matched to the risks in the financial system, which had grown rapidly outside of commercial banks prior to the crisis. It also did not have a viable bankruptcy or resolution process that would allow large and complex financial firms to fail in an orderly way that would minimize damage to the economy. The regulatory and supervisory structure needs to be kept up-to-date with changes in the financial system, and to make it more resilient to a wider range of shocks.
LESSON 2: A strong regulatory and supervisory structure is not a substitute for strong crisis management capabilities.
While a more stringent regime is now in place in the US and in many other jurisdictions, no regime, no matter how well designed, will be able to prevent a financial crisis from occurring ever again. By reflecting on the lessons from the responses to past crises, governments will be better prepared to respond more effectively when faced with the next crisis.
LESSON 3: Prepare (at least) for what is likely.
Understand that the causes and manifestations of future crises will likely differ from those of this crisis, but prepare for a few conditions that are likely to be present in any financial crisis. These include sudden and sustained reductions in liquidity in financial markets, widespread loss of confidence in the adequacy of financial institution capital even if they comply with regulatory standards, and the potential for abrupt failures of financial institutions that could seriously disrupt credit and growth. Authorities should practice responses to manifestations of these common types of conditions.
LESSON 4: Prepare to be surprised.
Recognize the limits of real-time information and inherent ambiguity and unpredictability associated with navigating effectively in crisis situations. Organizations should develop the capacity for rapid innovation, experimentation, and learning.
LESSON 5: Communicate before, during, and after periods of financial crisis.
Communicate with the public on an ongoing basis about the role that the financial system plays in the economy and the principles that will guide policy actions in a crisis. Communication alone cannot ... By Nellie Liang
This week at Brookings, the Hutchins Center on Fiscal and Monetary Policy and the Yale Program on Financial Stability gathered dozens of experts who, ten years ago, were on the front lines of the government’